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August 23, 2010 01:00 AM

New Jersey muni-bond case could start trend

Bloomberg
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    The Securities and Exchange Commission's fraud case against New Jersey may presage a wave of lawsuits seeking to crack down on misdeeds by public officials who raise money in the $2.8 trillion municipal bond market.

    New Jersey on Aug. 18 settled claims it didn't disclose to investors that it failed to put enough cash into its two biggest pension plans when it sold $26 billion of bonds from 2001 to 2007. The case is the first SEC fraud charge against a state and follows the creation of a unit set up this year to focus on municipal securities and pension funds.

    “They will be looking for other cases,” said James Doty, a former SEC general counsel who's now an attorney with Baker Botts LLP in Washington. “It's a harbinger that they expect disclosure standards to be scrutinized and be increased.”

    (For a look at the funded status of the largest public plans, go to pionline.com/fundedstatus.)

    SEC Chairwoman Mary Schapiro has pressed for tougher disclosure rules for municipal bonds, whose history as a safe investment has been jeopardized by dwindling tax collections and record budget deficits by states and rising defaults by local borrowers. Investment losses also left states $500 billion short of funds to cover promised pensions by mid-2008, even before the collapse of Lehman Brothers Holdings Inc. sent stocks tumbling, the Pew Center on the States said.

    “There are a lot of states that are significantly underfunded,” said Lynn Turner, a former SEC chief accountant who served on an independent panel that investigated the $3.7 billion San Diego City Employees Retirement System. The SEC sanctioned the city in 2006 for hiding gaps in its retirement system after the Internet stock bubble burst. “There's likely to be a dozen that have the same type of problems as New Jersey, and it's not just states, but cities too.”

    Miami has been under the SEC's scrutiny since December for failing to tell investors that it used funds earmarked for capital projects to replenish its general fund in fiscal 2007 and 2008, according to documents for a bond sale last month.

    The New Jersey case began in 2007 after the New York Times published a critical report on the state's pension accounting. The SEC found the state masked years of underfunding by failing to inform investors that $704 million listed as pension payments in documents for 79 bond sales from 2001 to 2007 were actually transfers of money already in the retirement system.

    The state also failed to disclose a $2.4 billion loss in the value of pension fund assets in 2001, the SEC said, which “created the false impression” that the $36 billion Teachers' Pension and Annuity Fund and the $10.6 billion Public Employees' Retirement System, both in Trenton, were adequately funded.

    New Jersey settled the SEC charges without admitting or denying guilt or paying a fine.

    New Jersey Gov. Chris Christie, who took office this year and has sought ways to cut the state's pension liabilities, said he was happy to close the matter.

    “I'm glad to have this problem behind the state,” he told reporters at a bill-signing event Aug. 19. “I'm glad that this administration has been able to end the bad practices of the previous administrations.”

    The resolution isn't likely to affect the state's ability to sell bonds, said Jeremy Ostow, an attorney who served as bond counsel on more than a dozen sales during the time covered by the SEC settlement.

    “I would be surprised if it had any material effect,” he said. “There was never any particular secret about New Jersey's pension system.”

    The SEC case didn't hinder the state's sale of a record $2.25 billion of short-term notes on Aug. 19. They sold to yield an average 0.33% after drawing bids from 11 banks. J.P. Morgan Chase & Co. was the largest buyer.

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